Does it make sense to keep six to eight months of expenses in an emergency fund? I always thought so. However, when I was doing my MBA, a classmate told me that emergency funds are unnecessary if you have a home equity line of credit. She said it makes more sense to use it to pay down your mortgage. If you lose your job, use the line of credit to tap your home equity.

In her opinion, you were doing nothing more than pulling out money you would have otherwise used for the emergency fund. Although you would have to pay interest on this money, she anticipated that the years of avoided interest on the mortgage would outweigh this. (e.g. if you didn't have to pay 6% mortgage interest on $30k of your previous mortgage.)

Does this make sense?

I think that Andrea's classmate has an intriguing idea. For many people, it may make sense to keep a smaller emergency fund, and to put the extra money into a mortgage (or into other investments). It depends on your risk tolerance.

Some say you need save a year's salary. Others believe $1000 is sufficient. Most advice tends to fall someplace in the middle.
How much do you really need? As usual, I recommend that you do what works for you. There is no one right answer. Examine your situation — your income and your needs — to decide how much you should save.

I've read a couple of books that advocate keeping only a small amount immediately liquid. These books argue that there are few catastrophes that would ever require you to come up with more than a couple thousand dollars on short notice. Insurance will mitigate many problems. For everything else, there's time to obtain capital: to tap into home equity, to sell stocks, etc.

In 2006, J.D. founded Get Rich Slowly to document his quest to get out of debt. Over time, he learned how to save and how to invest. Today, he's managed to reach early retirement! He wants to help you master your money — and your life. No scams. No gimmicks. Just smart money advice to help you reach your goals.

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There are 88 reader responses to "Ask the Readers: How Much in an Emergency Fund?".

limeadesays

The goal for my emergency fund is one year’s worth of expenses. You can’t underestimate the importance of cash. Not only are you secure financially, but the peace of mind and the confidence you gain are invaluable.

I’m not a fan of tapping home equity as an emergency fund. It also just doesn’t make sense. Put your emergency fund in a money market at anywhere around 4-5%. This is about what you’d save by paying your mortgage down since the interest there is tax deductible. Also, your home is not a savings or investment vehicle. It’s part of your living expenses. Don’t confuse this.

I think that the amount of an ’emergency fund’ is highly dependent on your risk tolerance and job stability.

If you’re in a stable job with excellent disability benefits, the chances of your income suddenly vanishing are extremely small. In this circumstance, using a line of credit as an emergency fund can be a good idea, since you’re confident you’ll have the income to pay down what’s borrowed.

If your job is less stable, or is more dangerous, you may want to have more cash on hand, in case you suddenly lose your income due to an injury or illness.

Personally, I think having a few thousand dollars readily available for emergencies is the minimum, but it’s probably unrealistic to have a full year’s salary available “just in case”.

All this “how big an emergency fund”, “pay off your debt” stuff gives me a headache. I can’t figure it out. I’m not an accountant or investment guy. I’m a programmer. Soooooo I program and when it comes to finance I play stupid. To cover myself, and my stupididty, I don’t have any credit card debt. I have two car payments and a mortgage payment. I put 10% of my salary in a 401k. And I have an emergency fund with close to $50k. I feel these moves keep me covered until I can learn more about investing and all the stuff that goes with it.

There is no one size fits all answer to this, and this is why there is such a wide range of recommended amounts. Most financial planners are taught that 3 months of reserves (6 months for a one-income household) is as a rule of thumb. The purpose should be to have cash available to cover short term costs, like waiting for the insurance company or while you look for a new job. If you are under insured (or self insure) you may want more. Home equity serves as a nice backup to a cash reserve should you deplete the whole reserve or temporary access part for a non-emergency. This strategy may be a nice compromise between an a large cash reserve and relying solely on a home equity line of credit.

Here is any easy (maybe even fun) way to “crash test” your finances. Make a copy of your Quicken, Money, Excel worksheet, or grab a blank check book register and simulate emergencies. Try injuries, illness, job loss, car gets stolen, day care evaporates, part of your house requires repairs, legal fees to mount a defense, whatever you can think of. You may need to do a little research, but this can help give you a sense of what your cash flow needs might actually be so you can plan accordingly.

I have pondered over this question for a very long time. I am single and rent an apartment. Although I have a lot of money invested in my 403B, I do not have much saved for an emergency. When I do have a few thousand saved, something comes up such as car repair, or my computer crashes and I need to use that money that was intended to be used in case I lose my job. This shows me that I need to save more than just a few thousand dollars. I think we all need to think of the unexpected expenses that can pop up on top of our monthly bills because believe me, that money goes fast!

My wife and I just sat down this past weekend to go over this question. With our first kid on the way now and us dependant upon my salary alone, we decided that having 5 months living expenses would be a nice cushion in case things go bad.

We keep that money in an money market savings account so we can quickly access it if need be. We also have no other debts except for the house note.

I agree with what most people are saying in that there is no single hard and fast rule here and it’s up to individual situations and risk tolerances.

Personally, I don’t think I need a lot in an emergency fund, for a few reasons: I’m in a profession that lends itself easily to self-employment or work as a contractor, so if I lose my salaried position I could still find enough work to pay the bills fairly easily. Also, my necessary bills are relatively low–my mortgage payment is less than 10% of my gross monthly income, and I don’t have a car. My other big bill is my student loan payment, and I could get a forbearance if I absolutely had to.

There are always other ways to scrape up cash, and credit cards are a viable short-term option for groceries and utilities. In short, while I like to have a few thousand dollars in cash just in case, I think that would suffice for me if anything happened. A year’s salary sounds absolutely insane, and even six months’ expenses seems unnecessary.

You friend’s advice about the HELOC makes perfect sense analytically. However, money isn’t just an issue of mathematics. Money is emotional.

Having a few months expenses sitting in a local bank conributes heavily to one’s peace of mind. Having to borrow funds when your car breaks down or you roof gets a leak only adds stress to the already stressful situation.

In addition, since it is so easy to borrow money from a credit card or HELOC, one’s definition of “emergency” tends to grow rather fluid over time. If you ever want to reach your financial goals, you have to get out of the vicious cycle of borrowing and paying back creditors.

As many others have already said, the exact amount of an emergency fund will vary depending on your needs. In our case, we’ve saved about two months’ expenses so far, but our goal is six months’.

I don’t know. I have always wondered what is considered an “emergency”?

Is it limited to things like losing a job and needing to pay for regular expenses? Car breaking down- is that an emergency ( I just pay stuff like that out of regular expenses)?

Someone broke my car window a couple days ago and stole my CD player and some other things- is that an emergency? Again, something I will probably just pay out of regular funds that I don’t consider an emergency fund. Maybe since I live below my means I have a perpetual emergency fund that isn’t designated as such.

If I had a large emergency fund, I don’t think I would ever be in a position to need to touch it. An emergency would have to be something pretty catastrophic. I would have a difficult time deciding to use it.

I also keep my expenses low enough that I could get by with any menial job, pretty much. I mean if I had to I could find something to do within a couple weeks or a month at any time. maybe not something I really want to do, but something to cover house, food, utilities- the basics. I could cut off my cable, cable internet, cell phone,etc if I really HAD to.

I think this all depends on a combination of things such as salary/lifestyle expenses, insurance level, number of dependents, etc.

Andrea’s classmate’s advice leads me back to a thought I’ve had for a little while now (and it’s not an original thought). The people with the greatest ability to fund a large emergency fund are the people least likely to need it.
For example, someone who is financially responsible and pays off their credit card each month typically has a large available card balance. If disaster hit, even if this person has no emergency fund, they have the card to function as one (albeit an expensive one). Someone who does not pay off their card each month typically won’t have an emergency fund either. The only difference is this second person probably won’t have the available credit to pay for an emergency.

I strongly recommend NOT using your home equity line for an emergency fund. Going into more debt is not a great way to deal with an emergency. Relying on a HELOC for emergencies fosters an attitude of lax financial planning rather than a proactive, controlled approach.

It’s vital to start with at least a small emergency fund ($1,000 is a good recommendation) to get you through the minor emergencies. As you pay off your consumer debt, you can then use the funds that were going towards debt to build a more substantial emergency fund. 3 to 6 months feels about right to me (I think we’re currently at 3-4 right now).

I agree that there’s no magical amount. Even if you decide on 3 months of expenses, there’s still a lot of variability. Will you save 3 months of bare-bones expenses? Or 3 months of expenses with your current fully-employed lifestyle? I recommend going through a few emergency scenarios (losing a job, etc) and imagine how you would live. What expenses would you eliminate? Would you eat out? Then plan on saving enough to meet those types of expenses. If you don’t plan on changing your lifestyle in case of an emergency, you might want to save a little more.

There’s no need to get too technical when determining how much to save because it’s still really squishy. And just remember that any emergency fund no matter how small can provide substantial help and security. As it grows it just provides even more.

I agree that on paper the HELOC idea has merit, but from a practical standpoint I don’t think it should be the primary emergency fund. I think it would make a better emergency emergency fund.

That said, most of my emergency fund is invested. I have some cash, but the likelihood of having an immediate need for 6-12 months worth of cash is pretty slim. I can divest my holdings as necessary and have cash within 3 days, which should be good enough.

I’m going to agree with several others here that emergency reserves are often overdone. Now, I’m really talking EMERGENCY reserves — a dead car and the need for a new one is not in the same category of a lost job or disability. If you consider a need to make a sudden purchase such a car, refrigerator or replacement TV an emergency then you need more short term reserves.

Otherwise, you should simply keep a portion of your savings in non-retirement investments (so that you don’t get a heavy tax penalty for withdrawals on them). Yes, they’ll grow more slowly than tax-advantaged retirement accounts, but they can be accessed in a few days to a week or so at most. If you have funds like that, you can use credit cards while liquidating assets, then pay them off immediately upon receipt of your money so that you pay no interest.

If you really want to avoid credit cards entirely, just keep a week or two’s worth of cash in a savings or money market account.

If you DO wish to treat a home equity line as a source of emergency funds, make sure you establish the line of credit BEFORE an emergency arises. You want to be able to write a check on that account immediately — and your bank might not like to offer you such a line of credit if you are already in an emergency situation.

Taking out a home equity loan when you become unemployed is not a good idea. You risk becoming both unemployed and homeless. Whether you call it an “emergency fund” or just “liquid investments” doesn’t matter, and there is no maximum amount.

Also emergencies are not just unemployment. They include medical emergiencies, natural disasters, etc.

Home equity credit is DEBT, not “pulling money out”. You “pull money out” of a home ONLY when you sell it. Home equity lines of credit are a form of BORROWING money that MUST BE PAID BACK WITH INTEREST.

As long as that is clear, you can make an informed decision about emergency funds.

I bet the MBA who wrote that home equity credit is “pulling money out” probably lives hand-to-mouth on a six figure salary… little net worth. Most of the MBAs I know are miserable managers of their own money.

First, define “emergency”. Is it a car breaking down needing a repair that you had not anticipated? Then emergency funds of $1000 – $2000 might suffice.

If you define an emergency as “a job layoff with little or no serverance pay from a job that is highly specialized and not easily portable”, then 6 months or a year of salary might be in the ballpark of “enough”. That is how I define an emergency, from personal experience.

If you have other fairly liquid assets, such as stocks, you don’t need as much cash in an an emergency fund. The odds of a long stretch of unemployment coinciding with a significant loss of value of a well-diversified stock/mutual fund portfolio are small (though still possible). So count your taxable brokerage account assets.

In a real pinch, you can also tap tax-deferred retirement plans such withdrawing IRA funds early (with penalties and taxes) and borrowing from your 401(k) accounts, but those should be a last resort because of the damage those actions cause to your long-term plans and you get only a short-term benefit (funds until the emergency is over).

It is very much a personal decision in regards to risk and circumstances. I think having enough so that you can sleep at night and not have to sell investments or sell a home is realistic. Also, personally I keep less due to the fact that both my wife and I work, whereas if we were dependent on one job I would want a larger emergency fund. We are generally aggressive investors and likewise aggressive with our money and do not have too large of an emergency fund (~10k) but then again we have no credit card debt or mortgage payment that we are locked into.
-Thor

This is one I struggle with, not so much from an “emergency” standpoint, but a “just living” standpoint. I’m not currently working and don’t expect to work again for quite some time. The challenge is trying to figure out how much I should simply have in cash vs. invested. 6 months of expenses? A year? I know that I’ll have to liquidate some of my investments as I go along no matter what, but how much to keep in cash for the time being is the challenge.

The concept of having an “emergency” fund is a good one. While it is typically cast as being a liquid investment that covers X months of expenses, I think that definition is a bit narrow and that the vehicles one uses to create a cushion for such an emergency should be more flexible and (as suggested), align to each person’s individual situation.

For example, when I was early in my career my main focus was on maximizing savings to cap out on my 401(k), etc. Emergency savings were not a high priority for me because:

A) Expenses were relatively low and entry-level jobs were plentiful
B) I didn’t feel like I could “waste” money in a cash account while not maximizing my other investments like 401(k), etc.
C) My parents

As I grew in my career and got a family, house, etc, the ability to weather an emergency more of a priority:

A) Income harder / takes longer to replace
B) Increased financial responsibilities
C) Responsible not only for yourself, but others

However, as I am still not capping out on both my 401(k) AND Roth IRA, I still feel there is some trade-off. Therefore, I do not specifically have cash set aside for an emergency, HOWEVER, in case of emergency, I can:

Granted, that is not to say these options are “optimal”, etc. For example, many would say you shouldn’t tap your retirement accounts. Generally, I agree. However, the total dollars you have available to you are the same. Whether I invested $100 only my retirement account or split it $50/$50 between there and an “emergency fund”, the total is still $100. Arguably, which account(s) the $100 sits in is thus less relevant.

Don’t get me wrong, you have to weigh your options and consider the potential consequences (ex: a 401(k) loan where you pay yourself back is much better than a distribution where you pay taxes and are penalized).

My point is that we are talking about an emergency (which are hopefully rare) and there are a number of “emergency” options available…not just the cash one.

Generally speaking, I think you should be absolutely focused on maximizing wealth and making full use of tax-advantaged vehicles to do so. If those are maxed out, then perhaps you can think a bit more about having more ready cash available, etc.

Until then, I might offer the other emergency options I listed as viable (and for me, preferable) alternatives.

I have an emergency fund, but have never thought about how much it should be. I have an UK tax free account, ISA, which I put the maximum allowed in for two years which now gives me over 3 months salary.

I stopped putting money into my ISA account once we got an offset mortgage. Most of the spare cash goes into the offset to reduce the interest on our mortgage, however we can still access the money so can take money out if we need to, so I guess it works like an emergency fund as well.

I have a multi-step emergency fund. The first step is about $1000 in an ordinary savings account. It is low interest, but I can get to it quickly. I then have about three months savings in a money market account. Better interest and it takes a couple of days transfer the funds back to my checking account. Any savings on top of that goes in longer term investments that make more than the money market account. I also make sure that my credit cards balances are low.

I think there are two levels to emergency funds — the first being if your car needs a big repair or your heater/washer blows up, or (heaven forbid) you need a lawyer for some awful reason).

The other reason — what I like to call the “contingency fund” is to cover sudden income loss. Having been laid off with NO contingency fund and no severance pay, I think it’s really important to have at least a few months of LIQUID savings here — preferably more. My minimum comfort level here is 6 months. In addition I’d like another 6 months in something short term CDs or Bonds, something ultrasafe but hopefully earning a little more interest.

There’s no way in hell I’d rely on a HELOC as my emergency funds. When your emergency is over, at best now you have a debt to pay.

Great article & lots of interesting comments. My own $0.02 are that while it may not make the most cents economically (pun intended!), having a 3-6 month emergency cash reserve in savings / CDs / money-market funds buys you significant peace-of-mind. My goal is to have 6 months of cash (savings/CDs/mmf) at my current lifestyle saved up. The anecdotes I have heard are that having that cash cushion will really make you feel free — give you options to quit your job if it gets too bad, or recover from a medical expense or unemployment or serious car problem. Keep maybe a month’s worth liquid, put the rest into a CD ladder to earn higher rates.

I don’t like the idea of using HELOCs, credit cards, or investments (stocks/mutual funds/etfs) as my “emergency fund” because those all have strings attached. HELOCs and credits cards you have to pay back with interest, so as soon as you have your emergency, the clock starts ticking and that’s just additional stress that you really don’t need. With investments, the big risk there is that your emergency comes at a time that’s not convenient to Mr. Market. What if your emergency need happened on 2/26? Over the next 2 weeks, the market had dropped between 4-6%, some stocks much more. And if we run into a serious bear market like some warn (or like we had in 2001), your e-fund will shrink even further. Diversification will help reduce the risk, but not eliminate it. The money I invest is money I don’t intend to need for at least years, if not decades. Selling off investments should be done carefully & rationally, since it can have a serious effect on your long-term wealth and your short-term tax consequences. In an emergency situation where I need cash, I would not want to be forced to make such decisions since I will not be thinking rationally with a long-term focus.

And of course, you need to decide what “emergency” means to you. And it’s probably more like a spectrum — ie unexpected job loss is an emergency right now. Car that is aging and will need replacement is something to start planning for so it doesn’t become an emergency. House flooding or major appliance dying — more things that may require an emergency fund withdrawal.

Just a note for taking out a loan on a 401(k) — I’m opposed to it, especially in an emergency. And there’s no point in planning on it as a fallback. When I was laid off they wouldn’t let me take a loan out of my 401(k) — I either had to roll it all over or I had to withdraw it all.

Of course, since I had NO EMERGENCY FUND, I had to withdraw it all. By the time taxes and penalties were taken out and I was re-employed, my entire retirement savings was now also gone. THEN to add insult to injury, two years later the IRS audited me for that year I was laid off and demanded an additional $1000+ penalty (including accrued interest of course) for a math error that resulted in me getting too much distribution and not enough penalty the first time around.

Retirement savings should NOT be the plan for emergencies. Just please don’t plan that way — using retirement funds this way is because of a failure to really plan.

1) I define an emergency as something that causes significant but temporary hardship on your normal cash flow arising from medical problems or job loss. Basically I can always afford the emergency in the long run, but I just don’t have all the cash right now.

2) It is ok to use a line of credit to help the cash flow out as long as you know and can handle that risk. I hate to have $10,000 just sitting anywhere in low interest when I can pay down my house (Note: I’m in Canada where we can’t deduct our mortgage interest).

I’ve personally been through a medical emergency with our first child and after 2.5 months in the hospital and over $15,000 in extra expenses we used a line of credit to help cover it for the short term. In less than one year we had it all paid off. I know that is a risk in using credit this way, but I would gladly do it again because it works for me.

I think emergency funds for many people are way overrated. If your finances are fairly healthy (and you’ll know if they are), I think it makes sense to keep a very small emergency fund in cash, and then use credit cards for your real “emergency fund”.

By definition, a true emergency should be rare. And for those rare occasions, it makes no sense to have a big stash of cash sitting around when you have easy access to credit.

My emergency fund is about three months expenses and is also (like Kate Davis) in an ISA. I use my credit cards as an emergency emergency fund. I wouldn’t like to use anything like a HELOC as the risk of losing my home would cause severe insomnia.

My goal for my emergency fund is approximately 5 months expenses, which would cover living expenses and say the boiler breaking at the same time.

See, I don’t have a problem using a HELOC as an emergency fund. If it was a major emergency (job loss), I would be forced to leave the country because of my immigration status. Therefore, I would sell the house. I have the HELOC open now, so I would just pull the money, pay the movers, and run. Since I have over 20% equity in the house, and the HELOC represents about 5% of equity (at today’s market value) I don’t think this is a terribly risky scenario. The proceeds from the sale of the house would cover the HELOC and I’d have enough cash to tide me over.

At that point, we also have the family as a back-up strategy. My husband’s parents are rather well off and have a large house where we could crash until recovered.

I do have liquid cash for breakdowns, repairs, new cars, etc. I don’t consider those emergencies though.

@samerkand —
Here’s where I stand on relying on credit for emergencies. I’ve spent the last 2 1/2 years of my life sacrificing big time to PAY OFF my credit cards, more than half of which represents charges during an emergency layoff to survive. I’ve got another $10K to go. The last thing I’ll ever want to do again is rely on credit cards in that sort of cash flow emergency.

So — an 8 month layoff cost me thousands on credit cards and wiped out my entire retirement. Failure to be prepared, I counted on credit and retirement as my “plan” in the past. Please don’t make that mistake too.

I tend to lean towards pumping it back into your mortgage (after ensuring a basic fund that can handle most emergencies). Keep in mind that an emergency can happen at any time, but the corollary to that is that an emergency MAY NOT (AND LIKELY WON’T) HAPPEN AT ALL. If some big emergency does come up beyond your basic fund, your money is still there in your equity, you just have to fill out paperwork to get it. And as a bonus you won’t be (as) tempted to dig into the money to go on vacation to Hawaii

But what if some big emergency doesn’t come up? Then you end up paying your house off early, and all things being equal, that means that no matter what, you will generally always have a roof over your head.

I keep six months of reserves in a money market account and find this adequate for my families security. I do like clients to have HELOC’s avaiable for opportunities like a great investment or short-term major housing expenses. Using a credit line for weathering a set back is bad advice as this would increase your monthly obligations as you increased the balance. That being said if a credit line is the best you can do because your are incapable of saving money then use it sparingly. The challenge you may have is if you cannot save moeny then having access to your equity could be reckless as you may decide to buy a new car or take a trip etc…

Well, I don’t have a house… but I do have an emergency fund! I was able to get it over $1000 in about 5 months by putting 12% of my monthly net income into it. Now I plan on cutting back on that just a little bit and putting more towards paying down debt, one bill at a time. :)

Thanks, everyone. I’m not sure my point / my classmate’s point came through here. Instead of having, $30k in an emergency fund, you throw that money (in one chunk) at your mortgage. If an emergency happens (which I pretty much only count as unemployment), you pull that same $30k back out. It’s debt that would have existed if you had the emergency money liquid somewhere else.

For example, you have a home worth $500k. You owe $330k on your mortgage. Instead of having $30k in an emergency fund, you put $30k against your mortgage, bringing it to $300k. You keep your mortgage payments the same. If an emergency (e.g. unemployment) comes up, you pull the $30k back out. You are in no more debt than you would have been if that money was sitting in a bank account. In fact, you’ve instead been avoiding 6% interest and putting more toward the principal, so you’re ahead.

The key here is that this money has been put down on your mortgage. It’s not just a home equity loan — it’s a loan that pulls out the money you put in for this purpose.

I should note that I live in Canada, where mortgage interest is not deductible. Also, we have unemployment insurance for a year, here.

I would never pull this money out for anything else. I do not consider roof repairs, car repairs or the like to be emergencies. I instead have a bank account with money set aside for these purposes. And I always have enough in the bank to pay my credit card in full every month. (I basically just use the CC as a convenient interest-free 3-week loan that gives me 2% back on everything.)

I don’t have a high ratio mortgage. Even if the local housing market drops 25%, I will still be ahead on my mortgage (and still have room to pull out that emergency fund).

I’m not worried about being approved for a HELOC — I’ve already got one that’s about 1/2 of our annual household income. The balance on that and everything except the mortgage is $0.

I just wanted to weigh in with these points, in case they change anyone’s suggestions. I would have been here sooner, but it didn’t work out. :)

I had been claiming that it’s far better to use a Home Equity Line of Credit for almost a year now. I think Samerwriter had it right, “By definition, a true emergency should be rare. And for those rare occasions, it makes no sense to have a big stash of cash sitting around when you have easy access to credit.” Basically you are losing thousands and thousands in opportunity cost by not having this money optimally invested.

They don’t change my suggestions. I think, frankly, that it’s a stupid idea to do this with a HELOC. If you ever pull it out, you’ll be subject to interest and you’ll have to pay it back.

Wouldn’t it be better to just have the cash sitting and ready for you? If you deplete it, you’ll have to build it back up again but there won’t be any interest.

I’m coming from the perspective of losing a job too — if you lose a job you want to be able to be as liquid as possible. Including being able to sell the house if you need to. And given the volatility in the job market, I think its foolish to assume a layoff won’t happen to you.

If you are going to pursue the HELOC idea, at least keep a portion of cash reserves — at least $5K or so. That way hopefully you won’t have to do the lunatic maneuver of tapping a HELOC because you need groceries and an interview suit.

I feel strongly about this because I’ve been through a layoff using stupid money. (and I don’t have a house now, partly because I’ve been through a layoff using stupid money)

Yes, there’s interest on a HELOC. But if you go, say, four years with continuous employment and then take out a HELOC and have to pay it back over four years, isn’t this the same as the four years of foregone mortgage interest?

And, if you have, say $200k equity in your house and you take out a HELOC for $30k, your equity is $170k. This is the same equity as if you had never paid down the mortgage with $30k in the meantime and you are still paying interest — over 20 or 25 years. So it shouldn’t keep you from selling your home.

In my way of thinking, $10K in the bank earning some amount of interest is appropriate for an emergency fund. A CD or Bond is less desireable but ok. A HELOC is not. Why? Equity should not be used as a savings account or a line of credit. Period. I simply object to it.

IMHO, the reason the real estate market in the US is in trouble right now is partly because people take inappropriate liberties with their equity.

I ask again, if the idea of your mortgage sitting there is so onerous, why not keep $5K or $10K in cash, and pay the rest on the mortgage, so that if an emergency happens you have the cash and don’t have to do funny things with your equity.

P.S. We have unemployment insurance in the states too, and I used it while unemployed. I got the maximum payment allowed, and it didn’t even make my rent payment. (I’d also exhausted my benefit before I got a new job.)

It’s great that you are a two income family — if you’re a consultant you’re probably not that far from having the ability to get a contract. Not everybody is in that position. I wasn’t, and though I’m very employable (great resume, mid-career, pertinent masters) I was laid off because the industry I’m in (IT) was in a downturn. So I had to ride out 8 months of no income.

I’m a renter, and my available credit lines only total $1,300, so using credit as an “emergency fund” is totally out of the questio for me. I currently have about 7.5 months of my take-home pay sitting in cash in a designated emergency fund. It would last me significantly longer if I were in hardship situation and living a truly bare-bones lifestyle. I’m in my mid-twenties, living in a very fluid rental market, in a very fluid time of my life job-wise, so the extra peace of mind is great.

Many consider unemployment as an emergency, and I do as well, but what about a medical situation where you can’t work? I know of a young lady who was diagnosed with cancer. Many days away from work and many treatments later, she seems to be back on the mend. Her insurance would only cover a portion of her treatments, and she didn’t have any income for the weeks she was out of work. I call that an emergency! To consider using equity as “insurance” is crazy!

I’m in a two-income family, too. Maybe I’ve got a morbid imagination, but believe you me I can come up with some nightmarish scenarios where in short order neither of us are pulling in an income, at least temporarily.

If I were, heaven forbid, on leave from my job because I was constantly at the bedside of my terminally ill husband or child, there is NO WAY I’d be willing or able to handle home equity gymnastics in order to keep the lights and heat on at home.

We have never had crushing job loss or major upheaval from a natural disaster, for which I am grateful. But I have had a taste of life-threatening emergency for one of my kids (thankfully it ultimately turned out to be easily remediable, and not a long-term problem), and it put our whole lives in a tailspin.

One of the reasons why you have an emergency fund in a place where it’s easy to retrieve if you need it is because if and when that emergency materializes, you may not have the energy and emotional reserves to deal with something more complicated.

For the record, our emergency funds (half in savings, half in laddered CDs) is enough for about 3 mortgage payments, or about 2 months of all living expenses. I’m aiming for 6 months but think it’ll take a year or two to get there.

It’s funny that you post this question as I was only just having this discussion with a friend. He believed that the money I have just started putting away each week for an emergency fund ($20) would be better put into my mortgage. I disagreed with him and said that for me the process of seperating some money out into another account for one purpose was much easier to manage and also gave me a greater sense of being in control. I think this is basically what all the people above said when they agreed in not using credit and mortgages as emergency funds have said. I think maybe we need to have a discussion of what is an emergency and how people who have an emergency fund use it.

I’ve got to side with db and others. You can get savings accounts or CDs online at 5%+ — if your mortgage is only 6%, your opportunity cost is only 1%+ at current rates (depending on how your savings interest is taxed), and if rates go up it may start to make more sense to save more than put it into the mortgage. Plus savings accounts are nice liquid investments, giving you easy access in an emergency situation.

And for those who are concerned that having such a large stash of cash will tempt you to splurge on a trip or other frivolous item, that temptation doesn’t go away if you have enough credit to do it. In fact, I would suggest that forcing yourself to save up a 6-month supply of cash will give you a much better fiscal discipline than telling yourself you’ve got enough credit / equity to pull you through.

I’ve sort of hedged my bets by putting some money toward my mortgage and keeping some more liquid. So I’m not totally on board with the idea of using a HELOC/LOC. Despite being a consultant, I’ve had some dry spells, medical emergencies and even unemployment (I wasn’t consultng at the time), as has my husband. And I tend to be pretty cautious.

I suspect my friend is more confident in her decision, because she bought her home for around $300k with $100k down around 6 years ago and now it’s worth around $700k.

@Andrea:
The issue is that a HELOC, or any line of credit, is debt. Debt in my book is something to avoid. You may well find the payments easy. The issue is having to make the payments.

The key, I think, to building wealth is to make choices that avoid installment payments of any sort. So I’m in that camp of person that thinks even a mortgage is something to get rid of as soon as possible. I’d much rather have a small amount of bona fide cash and no payments, than a big amount of net worth that is tied up on paper and payments.

I don’t really care what your MBA friend is doing — we really don’t know her situation. She could be doing great, or she could look wealthy but be tied up in massive debt.

I think that there isn’t one strategy that suits everybody (and probably, people are not following the strategy that suits them best).

Not everyone feels that debt is an inherently bad thing, not everyone mishandles credit, not everyone is happy with opportunity cost, and the converse is also true, not everyone is comfortable with debt, not everyone can handle credit and not everyone is concerned with opportunity cost.

Having a strategy to use in an emergency that will provide access to cash, is much better than having no strategy. Nobody knows for sure whether their strategy will be optimal in any given emergency so if the strategy you’ve chosen is thought through and doesn’t keep you awake at night then its probably ok.

@Andrea: read plonkee’s post. Your friend’s strategy may be a great one for her but not for everyone else. Sure, $30,000 in savings and $30,000 in home equity are both assets valued at $30,000. But taking out a home equity loan is not the same as drawing down a savings account.

I can definitely see how someone in a stressful emergency situation (whatever it may be) would only be more stressed out by having to take on another debt payment at that time and by knowing that even though she’s currently jobless or sick or whatever, she will in the future have to come up with another $30,000 + interest in addition to her other debts. But some people would be fine with that, and the HELOC might be a good solution for those people.

If there is a credit crunch, as might happen if the subprime meltdown extends to prime markets, then HELOCs will be much harder to come by, and existing ones might be much restricted.

Not so long ago, banks were tighter with credit and would only lend against a mortgage for ‘practical’ purposes such as home renovations, etc. If those standards return, then a low-interest HELOC may not be there when you need it for emergency funds.

Though you might think a credit crunch unlikely, emergency funds should not depend upon what is likely. An emergency is by definition unlikely, and an emergency fund by definition is a highly liquid, guaranteed source of cash. A loan which depends upon a lender’s willingness to lend a given amount at a given time does not therefore qualify.

A bank can cancel the borrowing privileges of a HELOC at any time, for any reason. They’re more likely to cancel it if the economy sours. Coincidentally that’s the time you’r emost likely to need emergency cash.

An emergency fund is for insurance, and that insurance has a cost associated with it. Whether it’s opportunity cost because it’s sitting in a money market or cost is in the form of increased risk form of using available credit or liquidating other investments, it has a cost. Just like there are no shortcuts to riches, there is no free insurance, just different ways to go about it.

There is no absolute mathematical solution because there are too many unknown variables, if there were, we wouldn’t be debating this. This, like many other polarizing financial concepts, will have advocates for both sides expressing religious-like zeal for their position.

Know your costs, know your risks, know your alternatives and then make a decision that best suits you.

My understanding is that HELOC and refinances are typically “Recourse” loans in many states. That is, only initial purchase home loans are “no recourse” in these states. “No recourse” means that the loan is secured by the asset (house) and the lender has “no recourse” to your other financial assets if you are foreclosed on.

With a “recourse” loan (potentially any refinance or a HELOC), if you can’t make the payments and are foreclosed on and should the sale proceeds not pay off all the loans, the lender can choose to still come after you for the remainder owed. This scenario seems like it would become more likely in a time of declining house values, particularly with a larger use of HELOCs.

The bankruptcy laws were quietly changed significantly several years ago also. I don’t understand the differences, but the banks were the ones lobbying for the changes. AFAIK, credit card debt is still discharged under bankruptcy but HELOCs are not. So the banks advertising for people to HELOC their way out of credit card debt amy not be very altruistic.

Another fun wrinkle: If you can’t pay the mortgage, the bank may accept a “short sale”, where the proceeds don’t completely pay off the loan. The bank in this case has decided to accept less than the amount owed, forgiving some of the debt. It turns out that the forgiven amount of the debt is treated as INCOME by the IRS for income tax purposes. The bank will report it because this is the only way the bank gets to write off the loss for its taxes.

In these days of extreme stress in the housing market, these edge cases of foreclosure, short sales, and bankruptcy laws become much more important to understand. If your emergency has the potential to end up that badly, make sure you investigate the details.

How much you need in an emergency fund is determined by how long you think the emergency will last, how long it takes to regenerate that emergency fund, and the likelihood of another emergency happening during the time when you are regenerating that emergency fund. If you think an emergency is going to last 3 months, and it takes you a year to build back up the emergency fund, and you think that during that one year time, you might have another emergency lasting another three months, then you should have an emergency fund that will last you 6 months.

I have a nice solid number that I like to suggest: At least $4000. It’s based off my own personal experience, and obviously people should adjust it to their own lives. But here’s where I got that number:

My sister’s dog had an intestinal blockage, and it cost them $4000 in emergency vet fees. This is the largest, unexpected, “need the money right away” expense that I’ve seen in my family, so that’s why I go with $4000.

As I mentioned, I still haven’t jumped on board with what my MBA friend suggested. (And I only mentioned her situation, because I thought perhaps someone with no debt other than a $200k mortgage and several hundred thousand in assets might have a different take on things.)

But let’s say you put $30k against your mortgage and arrange for a LOC, not a HELOC. Yeah, the interest rate will be a little bit higher. But it isn’t tied to your home. And now let’s say that the $900 a year you save on your mortgage by chucking in $30k is then set aside in a bank account. (I’m in Canada – no interest write off) So you’ve got extra equity in your house (if you need to draw on a LOC) and you’ve got some money set aside to help with interest. What about that?

I must admit that I’m a conservative. However, I did pay down my mortgage by $30k once I set aside $30k in an emergency fund. So I’m twice as prepared and I figure I can always pull out that extra $30k if I need it.

I think what constitutes an emergency is different for different people. If you’re in your first job living paycheck to paycheck and cannot turn to your family for help, then a million tiny things (like a hole in your work shoes) can count as emergencies, and they can happen almost monthly.

For me, the following things feel like emergencies:

1) Some annual or semi-annual expense comes due. I save monthly for this. (I choose the amount by looking at my current expense.)

2) Something breaks, but I want to keep having it. This still always surprises me, even though I know that things break. I am now saving a certain amount per month for household repairs, car repairs, and my next car.

For the house repairs, I used some rule of thumb (2% of the value of the house per year, I think) and then increased it with inflation. For the car repair, I used the average cost of my first car and now my current car (which is double). For health stuff, I’m starting with $100, which is just a random amount I will modify later.

And I have homeowner and auto insurance, but I try never to use that because they will raise your rates–I mainly use it for bankruptcy prevention. Oh, also I could break. I have health insurance and have finally starting saving a certain amount each month for health costs.

3) I lose my income. I am unlikely ever to be laid off because I work for the state, so I don’t actually worry about that. But I do have long-term disability insurance plus enough sick leave saved up to cover short-term disabilities. It would also be nice to be able to just quit at any time, but for now I satisfy myself with saving for retirement in 7 years and 10.5 months, not that I’m counting, yes I am.

I so far have been saving the maximum IRA contribution (in addition to my employer’s forced pension savings), but I just added some for a new ROTH 403(b).

There are other horrible things that can happen, like you have to travel to visit needy relatives, or you really want to give money to friends or relatives, etc., but these will always surprise me. My current plan is to borrow funds from one of my other categories for that. I can only remember one of those things happening (several times) and that’s wanting to subsidize a relative for a once-in-a-lifetime opportunity, usually a family trip that they can’t afford. I’ve just taken that out of my own travel fund.

My money is actually stored mostly in stocks, but with $500 in a local checking account for very good liquidity and $1000 – $2000 in a high-interest online savings account which usually gets tapped when one of those annual payments comes due. These amounts were selected based on past experience.

It’s true that stocks are risky, and that just when you’re getting laid off (or in my case, my relatives are getting laid off) is when stocks are plummeting. But I figure that if my stocks grow 10% or more per year and then drop 25% right before I need to sell them, I probably still have more money than if they’d been growing at 2-5% a year the whole time and then not plummeting right before I need them.

I have also used credit cards sometimes when several things happened at once and I didn’t want to sell my stocks but I still had my job.

There are several reasons for the often cited “three to six months of expenses” guidline. 1) If you are out of work due to illness/injury and do not have short-term disability insurance, your long-term disability insurance probably takes effect after 3 to 6 months. 2) Conventional wisdom held that if you lost your job, 3 to 6 months was enough time to find employment. 3) In the event of a disaster (i.e. home is no longer habitable), 3 to 6 months allows time for insurance processing. 4) It is generally a large enough savings to cover unanticipated immediate needs (i.e. sewer back up in the basement).

While #4 may still be true, the other three points are often not. #1: today, most job benefits do include short-term disability, and in fact the long-term benefit is a bigger problem (Social Security integration — that’s a story for another time!) #2: time between jobs will vary widely depending on your career, qualifications, willingness to relocate, etc. (A 2-income household is both a blessing and a curse: one unemployment means you only lose ~50% of income, but it makes relocation more difficult.) #3: we have all heard horror stories about people along the Gulf Coast who are still waiting for insurance payments 18 months after Hurricane Katrina.

In the end, you want to ask yourself what your “emergency fund” is really for, and that will guide you toward the necessary amount.

There are so many reasons this is a bad idea.
The primary one is what if the “emergency” is something that damages the house? An emergency fund is not simply a form of protection from the loss of a job.
I have more than $50k in a money market mutual fund. It is an emergency fund but it also serves as a nice cushion to even out unusual cash flow situations. When we had to have our roof replaced last year I paid the $10k out of that fund and then slowly built it back up.
It’s nice to be able to not have to specifically save for large purchases since you don’t always know when they will occur. You definately don’t want to be in a situation where you need to tap a HELOC to pay for $2000 worth of unexpected car repairs.
Trying to squeeze every last dime of interest out of your investments is foolish in the long run because eventually you will get burned and all your extra savings will get eaten up in some unforseen event you are now unprepared for.

I live and work in Tokyo, so my situation is a little different than most. My original plan was to put away approximately three month’s worth of my salary for an emergency fund before building up an investment fund of approximately 1,000,000 yen (a little less than $10K) and getting cracking.

However, the DISMAL interest rates (0.5%, 0.6% or so…and I’ve looked for better) have caused me to rethink my plan in slightly more aggressive terms. I have about one month’s worth saved up already, so once the credit card is cleared off next month, I plan on doing some relatively low-risk investments (e.g. index funds, possibly currency) to try and get a return of somewhere between 5% and 10%. This will also serve to get my investment feet wet and, once I’ve got a fair amount riding in some safe, easily-accessible investments, I’ll start looking towards more high-risk/high-return strategies.

My thinking behind doing so takes into account the facts that a) it’s very hard to get fired in Japan; b) if the unthinkable happens, companies are generally very understanding and, if that fails, state insurance is very robust; and c) you would get about the same return on stuffing your money into a mattress as you would on putting it into a standard savings account.

I guess the point, then, is that you really have to consider first what exactly your emergency fund is FOR and, once you have, consider just how much risk you’re willing to tolerate. As an individual with a very low debt level, I’m willing to be a little more risky–if I had a family riding on my ability to provide, though, you can bet that the story would be very different.

i break the traditional e-fund into e-fund and contingency or income disruption fund. I’m dead set against HELOC, because you are not guaranteed to getting a HELOC. Let me see, you have no income source and you are applying for a loan = not a good combination. Since you cannot guarantee you are going to get a HELOC, nor can you guarantee how much interest (what’s your credit rating?), this is setting yourself up for a complete disaster. the idea of having cash reserves is so you negate all these factors when you need the money the most.

for me, e-fund is for major repairs or medical/dental issues. contingency fund is for income disruptions. it is variable from person-to-person based off of your job volatility. so the amount will depend. i shoot for mid-level scenario of two major things (i.e. medical/dental and car/house repair) plus income disruption. the e-fund needs to be liquid, whereas the contingency fund can be semi-liquid in laddered cd’s or such, since it is a month-to-month need basis. you have to assess what is likely to occur. if you have an old car or an old water heater in the house, the probability increases of needing cash for a repair. if you have health issues, the probability of needing to seek medical care is higher. if you have older parents or sick parents, you might need cash on hand to buy plane tickets. again, there should be a difference between emergency funds and income disruptions funds.

we have 1 month expense emergency fund immediately available in a money market.

we are setting up a good cd ladder. right now we have a 3 month ladder and we are looking to have a monthly ladder. that is to have a cd mature every month, that way if we have an emergency longer than a month we have access to the funds and are gaining more interest than a moner market.

I’ve been pondering this a lot lately. Last week I paid of my HELOC, so my only debt is my mortgage. I have about $3500 in a liquid savings account; and $1000 in a brokerage account that is slightly less accessible.

My dilemma is whether to put the amount I’ve been paying monthly on my HELOC toward more liquid “emergency” funds, put it toward eliminating my mortgage (@5.25%), or put it toward my retirement investments. I already put 10.5% of my income into a 401(k).

The answer is different for everyone, isn’t it. Personally, I’d love to be out from under my mortgage. At the same time, I can’t easily pull cash out of my home other than taking an advance on my HELOC. What to do, what to do…

Andrea, I disagree. You’re NOT ahead. Why? Because you are not “pulling money out” – you are BORROWING AGAINST YOUR HOUSE, AND IT HAS TO BE PAID OFF. By doing what you’ve described, you’ve given yourself a second mortgage and put significant additional risk on the roof that’s over your head. If you’re unemployed for a long time (your definition of “emergency”) and can’t make a couple of payments, you’ll lose your house very quickly. I’ll never understand why so many people put their home at risk in this way. Same thing with credit cards – you’ve got to pay them back sooner or later. Why take on that risk? I don’t own a home, but if I did I’d never ever set up a HELOC to serve as an emergency fund, nor would I rely on credit cards.

I’m currently building up my checking account with the goal of always having $1K there. That will be the first line of defense – to cover things like winter heating and car repair, so that I don’t have to use the EF for smaller things. My emergency fund is currently 3 months of living expenses, and I’m working on getting it to at least 6 months. I keep my EF in a bank savings account – not the best interest, but the large balance means I can do all my everyday banking without worrying about monthly service charges, plus the convenience of a large ATM network if I ever needed to tap the EF.

We are a one income household and my emergency fund target is 6 mos. of take home pay, which I roughly consider my living expenses (i.e., after deductions for taxes, ins, 401k and diversion of a small amt to a general svgs a/c). I have almost 5 mos. saved and it’s a big relief to have rebuilt the fund after using a big chunk of it for home improvements last year (no, they weren’t emergencies). I’d prefer my emergency fund to be sitting there strictly for emergencies, but quite frankly I don’t do a budget and haven’t tried to determine/calculate how much to put aside for home and auto repairs/maintenance. I’m new to this site, so I’d be interested in seeing if there’s anything here about how people do that and where they stash that money (separate bank accounts, etc.)

I also disagree about using a HELOC for emergencies – after all, my idea of an emergency fund is to not have to lose my shelter, and the potential inability to repay the heloc is akin to inability to pay the mortgage.

We are shooting for 4 months necessary expenses. This does not include things like cable TV or ballet lessons for our daughter. It’s for food, utilities, mortgage, and internet to find a new job. 4 months expenses for us would also equate to the amount we’d spend on a reliable used car in the event our 95 Jeep decides to die on us.

Above all, emergency funds need to be LIQUID. Stocks can go up and down. Murphy’s Law dictates they will be down when you need the funds. Put it in a high yield savings account or CDs.

I can tell you from personal experience, have 6 months expenses in an emergency fund. Two years ago we bought a beautiful house that we could easily afford on my husband’s salary and profits from his business of 12 years. We put 20% down and have a 30-year fixed mortgage so we had plenty of equity – and I saved 8 months’ expenses into a set of laddered CDs. Well, last summer one of his big clients broke a contract, stiffed him for a lot of money, and his company couldn’t recover because of the down economy. He stopped drawing salary in November and the business went down in December. I was working by then, but not making much. We had huge mortgage payments to make on a home that had lost 25% of its value, tuition commitments for our kids’ school, a lawyer to pay to protect us from the business bankruptcy, and everyday living expenses to meet too. Running up balances on our credit cards or a home equity line would have been the most foolish thing we could have done.

Sadly we now have to declare personal bankruptcy because of the business debts. But with our emergency fund we were able to keep our personal credit clean and our heads high. The good news is that my husband has a job again (after 6 months) and my business has picked up…and although we will have ultimately lost a lot of money because of all of this, we have a renewed commitment to re-building those reserves, divorcing ourselves from the “rat race” and concentrating on achieving financial independence as quickly as possible. I hope others will read this story and consider it a cautionary tale and a wake-up call…good luck to all!

I was working toward the 3 months of emergency funds and was doing ok. But Murphy decided to vist me. An abcessed molar which needed a root canal. Ouch two ways. Foolishly I had not signed up for dental unsurance at work. So a big bite was taken from my emergency fund. I learned the valve of having this fund. I also will get dental insurance at the next open enrollment. Thanks to JD and all of you for your wise thoughts and information!

I have to totally disagree with having a HELOC for an emergency fund. As has been mentioned several times, in the event of a real emergency (hurricane, tornado, flood, etc), banks will clamp down on their HELOC’s or cancel it all together. In addition, with tightening lending standards these days, banks are ready to just willy-nilly give access to equity that may be in your home. I think it might be best to have one open and unused just in case something truly catastrophic happens in your personal life (health deteriorates, etc). We personally shoot for 6 months of take home pay to be in savings and laddered CD’s at our bank. We also have a seperate savings account for budgeted trips and events during the year, so if push came to shove we could cancel those planned trips and use that money as well (which is not included in the 6 month calculation above). So I would vote we have almost 8 months in liquid assets. We are a military family, and although everyone thinks that is like the most stable income on the planet right now, you never know where/when the next major move could come, and each time I have to find a new job at his new duty station. So there may be extended time periods where we are living off one income, which we can do and still save and invest, but not nearly as much as we want. Also, since we rent each time we move, we generally need a security deposit, plus an additional 1 to 3 months of prepaid rent to reserve a home in a new area. This adds up quick! So in years we move (which is every even year right now), we divert savings and investing to a “moving” account that pays for these expenditures, including a trip to the area to go house shopping. So our “odd” years are ones in which we save the majority of our cash for investing and the even years are the moves (which usually follow with at least 3 to 4 months of me being unemployed). So our emergency fund continues to grow, but our savings and investing amount tends to change depending on whether or not we have a move that year.

Just for informational purposes: We have moved 5 times in 8 years of marriage. We went from FL to Norfolk to Rhode Island to Pensacola, to Mississippi, and 2 different stations in Washington state. LOL. We are now facing a move to San Diego for 2 years, then Monterrey Bay (yeah the closest move we have had yet! Just 4 to 5 hours north!), and then to Washington DC, then probably to Hawaii, and then to Belgium. From there, who knows. LOL. Got to love the military. LOL.

I have a friend who got laid off in May 2009. Today, Jan 2010, my friend is still aggressively looking for another job. Every credit card has been exhausted just to cover her mortgage all these months. Her house would be paid off 6 years from now, she has exhausted her resources to keep from losing it. So, how much is enough during a recession? You do the math, but I can tell you that books that say that you need “a couple thousand dollars” should be thrown into the fireplace.

I’d like to bring this thread back to life to ask if people have changed their approach given the state of the economy. We are a two income family, no children and we own our home. We are a few years into a 30 year mortgage. We have saved a year’s worth of basic living expenses in an online savings account, and I sometiimes worry that that isn’t enough!

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My name is J.D. Roth. I started Get Rich Slowly in 2006 to document my personal journey as I dug out of debt. Then I shared while I learned to save and invest. Twelve years later, I've managed to reach early retirement! I'm here to help you master your money — and your life. No scams. No gimmicks. Just smart money advice to help you get rich slowly. Read more.

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